The coronavirus, or Covid-19 pandemic, has thrust the world onto a path leading to an economic collapse of epic proportions. In this constantly-updated blog we follow the progress of the crisis.
The Stage of the Crisis: The Counterattack/The Flood
Updated 22/12/2020 (previous update 20/11). All updates are presented in bold.
In the December 2018 issue of our Q-Review, we outlined the likely scenarios of an approaching global economic collapse. But, like most things in life, such a dramatic event is unlikely to proceed in a purely linear fashion. There will be different stages within it.
In December 2019 we outlined these stages, which are likely five: the onset, counter-attack, flood, calamity and recovery. Here, we briefly define the characteristics of each, updating them with recent information.
The Onset of the crisis
In the Q-Review 4/2019, we specified that at the onset, stresses that had been building in the credit markets since the summer of 2019 would explode, shrinking if not eliminating entirely the exits from many parts of that market.
Downgrades of corporate debt in the U.S. and peripheral sovereign debt in the Eurozone would push large fixed-income investors, including pension funds, into higher-rated bonds, which would in turn lead to large-scale selling of lower-rated bonds, forcing wider spreads and even more selling.’
This moment came in late February 2020, when a sudden panic gripped investors in both credit and equity markets after a surge in reported Covid-19 cases and deaths in Italy coincided with the collapse of OPEC talks. Stock markets crashed and spreads in the credit markets exploded. A frantic retreat to ‘safe-haven’ assets, including U.S. Treasuries, German Bunds and U.K. Gilts as well as cash and precious metals commenced.
For a brief period of time in mid-March, we were on the brink of a complete financial market meltdown. Then, as we also had envisaged in December, there was a frantic rush on a never-seen-before scale by global and local authorities to rescue the situation.
We envisaged that the second phase of the collapse would be the desperate efforts of authorities to stop the crisis by a counterattack.
We said these were likely to include the restarting and acceleration of QE programs and other market support initiatives, gigantic fiscal stimulus, increasing trade protectionism and possibly even calls for direct debt monetization (see Q-Review 3/2019 for an explanation).
These tactics have been employed in full force. Governments all over the world have pushed vast amounts of debt-financed stimulus into their respective economies. Over the past weekend, the U.S. Congress authorized a $900 billion stimulus program, which comes on top of the $2 trillion stimulus program already agreed to in the spring.
The Fed has become the financial market (see Figure 1) as it backstops U.S. Treasury markets, intervenes in corporate commercial-paper and municipal bond markets and short-term money-markets. Massive support by the FED and the “free money”-schemes of the government have levitated U.S. stock market valuations to levels not seen since, at least, the height of the “Tech Boom” in 1999.
China also enacted a massive stimulus programs in March, which has been kept running full-blast (see Figure 2). The infrastructure investment programs in China have been the single most important factor behind the recovery of the manufacturing sector across the globe.
The ECB has increased its ‘Pandemic Emergency Purchase Program’ to a €1,850 billion behemoth.
While the European leaders reached an agreement on the €750 billion “recovery fund”, it will still need to pass all 27 national parliaments. This is far from certain.
The Eurozone, with its massive and teetering banking sector, is the ‘weak link’ in the global Counterattack.
Now a new mutation of the Coronavirus is delivering a heavy blow to—first at least—the UK economy and financial markets. Thus, more economic stimulus from the Bank of England should be expected soon.
Regardless of the desperate efforts of global authorities to uphold the credit and stock markets, we are still facing a flood of corporate bankruptcies.
In December 2019, we asserted that the so-called “zombie” corporations, faced with collapsing global economic demand will start to fail on a scale unseen in decades. Unemployment will skyrocket and tax revenues will collapse. And, at some points, credit markets will crash despite of the massive efforts of central banks. We also envisaged that:
If one or more European banks weakens or fails, it will be likely to send the capital markets into a similar downward spiral.
While global authorities have been able to postpone the onset of the banking crisis through fiscal and monetary stimulus and debt moratoria, the problem continues to build under the surface. Thus, when the dam finally breaks, we will almost certainly be swamped by a wave of corporate failures.
Next, we detail the Flood phase in three crucial countries/areas: the U.S., the Eurozone and China.
The United States
Soon, the zombie corporations may represent 20% of US firms, the percentage of which is now increasing fast due to the unprecedented support operations of the Fed and the U.S. government, increasingly, one and the same.
The “Flood” has now clearly began in the U.S. Statistics by the American Bankruptcy Institute show that nationwide Chapter 11 bankruptcy filings surpassed the 2019 level in September. We can only imagine what the level of Chapter 11 filings would have been without the massive government support.
Jobless claims continue to accumulate, just below 900k, and far above the pre-Corona weekly record of 695k reached in October 1982.
Europe currently holds an unknown, but potentially a very large number of ‘zombie’ corporations. Their existence is also tightly connected to the existence of weak (or zombified) banking sector of Europe.
Moreover, over half of small and mediums-sized business in Europe say they face a bankruptcy next year if their revenues do not improve.
Debt moratoria are supposed to end in Italy during H1 2021, with the first ending at the beginning of the New Year. This is likely to lead to a catastrophic increase in non-performing loans held by Italian banks. We must wait and see whether the moratoria will be extended.
The profitability of European banks after the GFC has also been dismal, and as we explained in Q-Review 3/2019, these banks have been hamstrung both by OMT and QE programs and the negative rate policy imposed by the ECB.
The ECB’s stress test, published in October 2019, showed that half of the biggest banks in the Eurozone would not survive if financial counterparties and some commercial clients pulled their money from the banks. This is exactly what happens in a recession, which has now arrived. Just recently, the ECB warned that the largest banks in the region are “ill-prepared” for the fallout of the pandemic.
The onset of the European banking crisis is close.
Banking problems are also becoming more pressing in China.
Profits are plunging in China’s $45 trillion banking system at the fastest pace in at least a decade, bad debt has hit a record, and capital buffers are eroding. Also, for example, China’s four biggest banks face a combined $940 billion shortage, mandated by 2024, to meet capital requirements designed to protect the public and the financial system against massive bank failures. It is therefore no surprise that the share prices of Chinese banks have plunged to record lows.
The ‘hard landing’ of the Chinese economy is on the horizon.
At the end of November, the global corporate failures were already running at close to 2009 levels.
When corporate failures, or the Flood, or the Tsunami, truly begin, this will be visible both in the financial markets and in the public sector. Several sectors of the financial markets are likely to witness massive turbulence, collapsing prices and even complete implosion.
The “Flood” will have the biggest impact on the banking sector. The Fed and other central banks may be able to uphold the financial markets, but their ability to stem a banking panic is very limited.
In reality, central banks can only provide liquidity and try to establish a ‘bad bank’ to collect non-performing assets from bank balance sheets, but if the problems of the banking sector are widespread, as they now are, these methods will be insufficient to stem the ‘bank run’. Only governments can truly solve a banking crisis, by, for example, providing fresh capital to banks, but many are heavily indebted now, especially in Europe.
An utter economic collapse, Calamity, will follow.
Massive global deflation will appear, led by an ugly chain of bank and corporate failures. Global liquidity will collapse and stock markets will crash in a spectacular fashion.
The value of the holdings of public and private pension funds, charitable endowments, bank trust funds, insurance company general and variable accounts, and stock and bond mutual funds will crash in short order in the Flood. Even lowly money-market funds may be at risk, just as they were in the 2008 financial crisis.
Due to both crashing capital markets and banking sector bankruptcies, joblessness and poverty are likely to explode. Simultaneously, government tax revenues will collapse as incomes retreat and capital gains evaporate.
As governments spending skyrockets in an orgy of Keynesian counter-cyclicality, national deficits will hit all-time highs on both an absolute and relative basis. Those central banks that have initiated debt monetization will have no alternative but to accelerate their programs. In their desperation, many other central banks are likely to follow.
Governments will try to save critically-important banks, which will require large-scale funding many countries—such as those in the Eurozone—cannot afford and will not be able to finance in paralyzed capital markets. This economic reality makes depositor bail-ins the only, if politically-unpalatable, option.
Confronted by new and harsh fiscal realities, pensions and other social security programs are likely to face serious cutbacks, by desperate governments. An economic calamity sets in.
However, even grimmer scenario exists. If countries worldwide are forced to reinstate broad and draconian lockdowns due to the second wave of the coronavirus pandemic, this could lead to the complete breakdown of global supply-chains. Global logistics routes would be disrupted by huge numbers of sick (or frightened) employees and the strict closures of both factories and national borders.
These ghastly factors, combined with soaring unemployment, business failures and market turmoil would topple the global banking sector. Bank losses would be likely be so great that though depositor bail-ins would be enacted, they would be insufficient to keep banks from failing.
The European banking sector would be likely to collapse completely, followed by an implosion of the global financial order. Global commerce would evaporate. The world would succumb into utter economic annihilation.
The only way to save the world economy would be enact full-scale socialization. This would mean never-before-seen central bank action.
In this scenario, the balance sheets of major central banks would turn into investment vehicles with limitless boundaries. Central bankers would decide which countries and corporations would survive.
However, even this would not be enough. With banks failing, central banks would be forced to issue Central Bank Digital Currencies (“CBDC”).
In such a scheme a central bank will become a competitor of the commercial banks. Thus, the central bank would function in the role of national banking supervisor, the ‘lender of last resort’ as well as a rival in the commercial banking sector.
It is clear that these obvious conflicts of interest could quite readily lead to the further corruption of any banking system.
As central banks are only quasi-independent organs of government, they could eventually become vehicles of economic coercion. Recently, China has frozen the accounts of critics of China’s Communist Party.
This would lead us well down the path to an unrecognizable Global Dystopia, where our present freedoms could be sharply limited, if not completely eliminated.
If the full socialization of our economies and financial markets does not occur, we expect the global depression to last 3-5 years. The initial collapse is likely to be over within three years (2020-2022).
Thus, the path to recovery will depend crucially on how far the ‘cleansing’ of the economy, markets and financial sector is allowed to go. If the banking sector implodes completely, the economic deficit will naturally be made much deeper leading to a systemic crisis.
However, if the essential functions of the banking sector are sustained, especially in Europe, we could avoid the deepest malaise. Moreover, if unsound banks and “zombie” corporations are allowed to go under or are wound-down methodically, it will clear much of the malinvestment from the economy, creating the foundation for a strong and sustained recovery.
So, if we manage to return to the principles of the market economy including, most crucially, a return to undistorted price discovery in the capital markets, we are likely to see one of the most powerful recoveries in global economic history. It would be led by robotization and general technological innovation, which hard economic times tend to foster.
Additionally, debt monetization, helicopter drops, CBDC, and other money-conjuring and take-over schemes would corrupt the economy, further making a sustained recovery impossible (see more from Q-Review 12/2020). This, unfortunately, is the path we currently are on.
Moreover, with the governments and the central banks assuming a much bigger role in the economy and society in this darker scenario, some form of fascism (which is, by definition, the merger of state and corporate power) would be the likely end-result of these developments.
We can do nothing more than hope that wise, courageous and far-sighted political leadership will spare us from that horrible fate.
Following the coronavirus outbreak, junk bond yield-spreads shot-up. They were tamed by massive support operations launched by the Fed, which have also pushed stock markets to new heights (see Figure 3). It remains to be seen how the genetic mutation of the Coronavirus will affect the financial markets.
It’s clear that the ‘zombified’ junk-rated companies cannot endure elevated yields and collapsing demand for very long before they start to fail. The massive unemployment already visible in many countries, is likely to be the main driver of corporate bankruptcies worldwide.
Based on the current assumption that Italy and Spain will start end their debt moratoria early next year, our “guessestimate” is that the financial crisis will begin between Q1-Q2 next year. If the moratoria are extended and combined with further fiscal and monetary stimulus, this estimate could be postponed.
However, there are several uncertainties lurking below the surface.
These include political uncertainties and even violent domestic unrest, and even the possible further mutation of the Coronavirus. The vaccine is likely to bring relief only in the latter part of 2021, which will be too late. Recently, we have observed how rioting against the current political system can erupt suddenly, both in the U.S. and in Europe. These all contribute to the tremendous uncertainty currently haunting economic forecasts.
We should focus on the path on which we have been placed. Unless we change it, this path leads to Dystopia.
We are arriving at crucial juncture. Failure to act with courage and foresight now will impose massive risks, costs and hardships on us and on future generations.
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